Of Two Minds
MAR 5, 2018
Fed market rigging has resulted in a false sense of security in the stock market. As buyers have caught on that the Plunge Protection Team will backstop stocks anytime they fall, buying the dip has become a rote, effective strategy. That is coming to an end.
The financial industry has reaped enormous "guaranteed" gains by betting against volatility. As volatility steadily declined over the past two years, billions of dollars were reaped by constantly betting that volatility would continue declining.
Other "guaranteed" trades have been corporate buybacks funded by cheap credit and passive index funds Central bank policies--near-zero interest rates and "we've got your back" asset purchases that made buying every dip a no-brainer trading strategy--have changed as banks attempt to dial back their stimulus and near-zero rates, and as a result volatility cannot continue declining in a nice straight line heading toward zero.
Higher interest rates have introduced a measure of uncertainty in another "guaranteed gains" trade--betting that interest rates would continue declining. All of these trades were "guaranteed" by central bank stimulus and intervention.
In effect, price discovery has been reduced to betting that central banks will continue their current policies -- don't fight the Fed.
Now that central banks have to change course, certainty has morphed into uncertainty, and risk is rising, regardless of what the VIX index does on a daily basis.